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Comprehensive Analysis of Set-Off Applicability Under the Insolvency and Bankruptcy Code

Introduction

In the recent case of Bharti Airtel Ltd. (‘BAL’) v. Vijaykumar V. Iyer[i], the Hon’ble Supreme Court (‘SC’) clarified that the provisions pertaining to insolvency set-off or mutual credit set-off, as elucidated in reg. 29 of the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 (‘IBBI Regulations’) do not find application during the corporate insolvency resolution process (‘CIRP’) concerning a corporate debtor (‘CD’) under the Insolvency and Bankruptcy Code, 2016 (‘IBC’).

Brief Facts

  • In 2016, BAL and Bharti Hexacom Limited entered into eight spectrum trading agreements with Aircel Limited and Dishnet Wireless Limited, concerning the right to use the 2300 MHz band spectrum. These agreements were contingent upon the approval of the Department of Telecommunications (‘DoT’), which mandated the furnishing of bank guarantees (‘BGs’) linked to specific licences and spectrum usage dues from the Aircel entities.

  • Further, when the Aircel entities challenged these requirements, the Telecom Disputes Settlement and Appellate Tribunal (‘TDSAT’) directed the Aircel entities to furnish the requisite BGs while simultaneously imposing an obligation upon the Airtel entities to pay Rs. 411.22 crores on behalf of Aircel entities to the DoT.

  • On 09.01.2018, the TDSAT issued an order that the demand of Rs. 298 crores was not sustainable and directed the DoT to return the BGs to the Aircel entities in compliance with its decision. Despite this order, the DoT failed to adhere to the directive and appealed to the SC.

  • In an interim order, the SC upheld the TDSAT directive but the DoT remained non-compliant with the order to return the BGs, thereby continuing the dispute. Thereafter, the Airtel entities made a payment of Rs. 341.80 crores due to the Aircel entities and the balance amount of Rs. 145.20 crores was set-off which were claimed to be operational charges, SMS charges, and interconnect usage charges.

  • Subsequently, CIRP was initiated against Aircel Limited and Dishnet Wireless Limited. The Resolution Professional (‘RP’) apprised BAL that they had suo moto adjusted the outstanding dues owed by the Airtel entities. This facilitated the discharge and cancellation of the BGs. Further, BAL initiated proceedings before the National Company Law Tribunal (‘NCLT’) that duly recognized the Airtel entities’ entitlement to set-off the aforementioned amount.

  • However, when the RP appealed before the National Company Law Appellate Tribunal (‘NCLAT’), The NCLAT allowed the appeal asserting that the set-off contradicted the objectives of the IBC. The NCLAT ruled that the set-off violated fundamental insolvency principles and safeguards, thereby emphasizing its incompatibility with the overarching framework of the IBC. Following the NCLAT’s decision, the Airtel entities appealed before the SC.

Held

The SC upheld the decision of the NCLAT, clarifying as follows:

  • The SC made reference to s. 53 of the IBC, which pertains to the distribution of assets in the liquidation process. It observed a clear distinction between CIRP and the liquidation process holding that in CIRP, the creditors cannot possess the legal entitlement to set-off their debts against the CD. In contrast, the Companies Act, 2013, recognizes the right to set-off, subject to specific conditions. Furthermore, it underscored that in cases involving partnerships and individual bankruptcies, the IBC, under s. 173, allows set-offs.

  • The SC further observed that reg. 29 of the IBBI Regulations provide for mutual credits and set-offs. These regulations are pertinent to the liquidation process and not directly applicable to the CIRP. Furthermore, the SC duly examined the provisions of s. 36(4) of the IBC. This section outlines the exclusion of certain assets from the liquidation estate. These excluded assets are expressly permitted to be set-off in the context of mutual dealings between the CD and the creditor.

  • Consequently, when an asset falls within the category of exclusions from the liquidation estate, it remains immune from distribution during the liquidation process. This legal provision bestows creditors, including secured creditors, with a preferential status to exercise their right to set-off, as enshrined under s. 36(4) of the IBC, thereby affording them priority over other claimants.

  • The SC observed that insolvency set-off stands in contradiction to the pari passu doctrine outlined in s. 238 of the IBC. This is primarily because it confers a preferential status upon certain creditors. The SC provided elucidation by clarifying that statutory set-offs, such as those found in o. VIII r. 6 of the Code of Civil Procedure (‘CPC’) or reg. 29 of the IBBI Regulations, generally do not find direct application within the framework of the CIRP. However, the SC identified two exceptions to this general rule:

a)  Contractual set-offs that were effectively prior to or on the commencement date of the CIRP.

b)  ‘Equitable set-offs’ prior to or on the commencement date of the CIRP.

  • Consequently, the SC upheld and authorized the contractual set-off, given that it had been established prior to the commencement of the CIRP proceedings.

Analysis

In this noteworthy judgment, the SC has clarified the application of set-offs in the context of the IBC, particularly during the CIRP. This ruling establishes an important precedent by pointing out that set-offs are not applicable in CIRP. However, it also acknowledges exceptions, particularly for set-offs that are based on contractual agreements.

This clarification by the SC is significant for practitioners in insolvency law, as it provides clear guidance on the exceptions to the general rule against set-offs in CIRP. Moreover, the judgment importantly notes that insolvency set-offs are not automatic.

Overall, the SC’s decision offers a balanced view on the issue of set-offs in insolvency proceedings, enhancing the understanding and application of the IBC among legal practitioners. This judgment is an essential development in insolvency law, providing clarity and direction in what has been an uncertain area.


End Note:

[i] 2024 SCC OnLine SC 4.


Authored by Purvi Garg, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinion.

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